- Big tech companies are investing in AI startups instead of committing to using their own cloud services.
- Some investors question whether such arrangements are artificially driving cloud revenue growth.
- There are gray areas in accounting rules that make it difficult to see how revenue is recognized exactly.
When Microsoft announced its multi-billion dollar investment in OpenAI earlier this year, the deal made Azure the “exclusive cloud provider” for ChatGPT makers.
Similarly, shortly after Google invested $300 million in ChatGPT rival Anthropic late last year, the artificial intelligence startup pledged to acquire it from Google Cloud. Another deal of a similar nature is underway involving Runway AI and a major cloud company.
And when Amazon Web Services partnered with Hugging Face earlier this year, the cloud giant promised to make the AI startup’s tools widely available to its own customers in exchange for becoming its own “preferred cloud provider.” .
Such deals are becoming more common in the enthusiastic generative AI space. They all share similar structures and similar problems. Investors and analysts say such deals could drive earnings growth through a practice known as “round-tripping.” That means the money will go out through investments in startups and will soon come back in the form of cloud spending.
Compensatory arrangements like this have been around for decades in the tech industry. But Ted Mortonson, managing director of financial services firm Baird, said it has come under closer scrutiny recently because it could artificially inflate cloud revenue, a key driver of Microsoft, Google and Amazon’s growth. is being poured.
“Investors are asking how much Azure will grow with OpenAI and if not,” Mortonson told Insider. “Everyone is seriously stress-testing their models because they need to understand what organic growth looks like.”
The question was the first question Morgan Stanley’s Keith Weiss brought up on the topic at Microsoft’s recent earnings call. Microsoft CFO Amy Hood said OpenAI will be treated “like any other customer using Azure” and its spending will be recognized as revenue “like any other customer with whom we have a commercial relationship.” rice field.
It is unclear what Hood meant by this. Is OpenAI a regular cloud customer who hasn’t received any investment money from Microsoft, or is OpenAI pouring Microsoft’s cash into Azure and the software giant just reporting its earnings in full anyway? We asked Microsoft for clarification, but a spokesperson said the details of the deal with OpenAI were not disclosed, pointing to Hood’s response to Weiss. When asked again by an insider, the statement came back: “We comply with all GAAP requirements.”
A Google spokesperson referred Anthropic to Insiders to answer questions about how Google accounts. Google also sent the insider a link to its latest 10-K annual report, but it made no mention of humanity. An Anthropic spokesperson said, “We work with a variety of cloud providers, including Amazon and Google.”
An Amazon spokesperson said the company “complies with all accounting rules and regulations and properly accounts for all revenues and expenses.”
“juice” your numbers
Some of Silicon Valley’s most prominent investors are confused and concerned about the trend. Venture capitalist Bill Gurley, an early investor in Uber, Glassdoor and Zillow, said: asked on twitter In February, it was debated whether cloud companies should be allowed to recognize such revenue when the investment effectively “needs to boomerang the same dollars into their own services.” .
“Can’t we have juice?” [your] Is your own number written in large letters? ‘ writes Gurley.
Benchmark Capital General Partner Bill Gurley speaks in an interview with Bloomberg Television at the Goldman Sachs Technology And Internet Conference in San Francisco, CA.
David Paul Morris/Bloomberg via Getty Images
Other investors quickly agreed. Mark Polus, who was once involved in the acquisition of Facebook and Amazon, I have written Such a deal structure would set off “accounting alarm bells” if the invested startup did actually spend, even in the absence of explicit reciprocal spending requirements.
Matt Garratt, USVP general partner and former head of Salesforce Ventures, called it a “round trip.”he Said This was a “big problem” for Salesforce Ventures, and the company had “safeguards to prevent this.” For example, venture funding could not be used as a return tool, and even if it was used, Salesforce would not recognize any return up to the amount invested.
“Otherwise, you’ll end up spending your balance in cash.” [to] “Artificially generating revenue,” Garratt tweeted. “Even if there was a round trip recognition (and it was just a coincidence), the accounting team would not recognize revenue.” A Salesforce spokesperson did not respond to a request for comment.
gray zone
U.S. accounting rules require that revenue be reduced by cash and other considerations that service providers provide to customers, but there are many gray areas, according to Patrick Badlat, an accounting professor at the University of Texas at Austin. It is said that there is
For Microsoft and OpenAI, explicit rewards built into the contract matter. For example, if the contract specifically states that Microsoft will invest in OpenAI “only if” OpenAI purchases an equivalent amount of cloud services from Azure, then according to U.S. accounting rules, “no revenue should be recognized.” No,” Badlert told Insider. .
OpenAI CEO Sam Altman speaks to media representatives on Tuesday, February 7, 2023, at Microsoft’s Redmond, Washington headquarters to announce the new AI-powered Bing search.
Jobel Tamayo/Getty Images
But he said there are circumstances in which cloud providers can recognize revenue even if they have additional arrangements with their customers.
Badrat said it happens when additional arrangements have a “different” economic substance than the provision of a particular service to a customer. Examples include, according to the Financial Accounting Standards Board, reselling products, granting licenses or rights to future purchases, and developing assets on behalf of customers. Microsoft, for example, has built several new products across the Bing search engine and Office productivity apps using technology from OpenAI.
Badrat said the issue was likely related to the “consideration payable to a customer” clause in US accounting rules. This section stipulates that a company must reduce revenue by the amount paid (including cash, service credits, and equity instruments) unless the payment is in exchange for “distinct” goods or services.
Even if the additional arrangement is a separate transaction, an entity should consider the fair value of payments and receipts to ensure that there is no discrepancy in revenue recognized.
Badlert said in an email that “the existence of additional arrangements could force or encourage customers to participate in agreements that help inflate the revenue recognized by the service provider (such as round-trip travel), so it would be gradual.” It requires close scrutiny,” he said.
different goals
Not all investors are skeptical of such deals. Some venture capitalists speaking to Insider said the big cloud providers are focused on growing the broader generative AI space and supporting partners, rather than exploiting revenue.
“I disagree with Bill’s opinion. [Gurley]“None of these deals are focused on generating revenue,” said Matt McIlwain, managing director of Madrona Ventures. We are focused on building a
Tomasz Tunguz of Theory Ventures told Insider that such deal structures are very common in the tech industry and that this is a “net positive for startups.”
“This means there is a symbiotic relationship between the infrastructure company and the application,” said Tungus.
Ethan Kurzweil, a partner at Bessemer Venture Partners, also said there are specific accounting treatments for how these transactions are recognized, so cloud companies aren’t “cheating” on the numbers. For Microsoft, the bigger goal is “to sort of leapfrog Google while positioning Azure as the primary cloud provider for these new AI models,” he said.
In addition, the ability to encourage AI startups with access to valuable computing power will allow cloud companies to pay a higher price for these investments and compete with traditional VC firms, says Bessemer, a partner of Bessemer. says Talia Goldberg.
Matt Murphy of Menlo Ventures said this could be the only option for many startups given the relatively tight capital markets. For big tech companies, this is an opportunity to capitalize on an opportunity that could last for decades, he added.
“The reality is, for companies that were starting and needing to raise hundreds of millions of dollars, strategic capital was the only way to fill the capital gap in the market,” Murphy said. “In this case, the result is a large-scale innovation that will last for decades. If you are a cloud provider, you are providing short-term seed capital to get these base model companies off the ground. is.”
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